WorldCom says it inflated books

Karen Kaplan And James S. GranelliLos Angeles Times Staff Writers

WorldCom Inc., the long-distance giant already embroiled in scandal, disclosed Tuesday that it substantially inflated profit for more than a year by improperly accounting for more than $3.9 billion in routine expenses, a revelation expected to force the firm into filing for bankruptcy.

A WorldCom filing would rank as the largest corporate bankruptcy case in U.S. history and leave creditors with nearly $30 billion in bad debt.

The disclosure of what could be one of the biggest financial frauds seems certain to be another huge blow to investors' confidence in Wall Street and corporate America after the flurry of scandals this year.

"You get the feeling that people have not finished lifting up rocks and finding all the worms," said Henry Hu, a securities law professor at the University of Texas.

WorldCom, parent company of MCI, also said Tuesday that it would begin laying off 17,000 workers this week, continuing a retrenchment that began last year.

The irregularities were discovered during an internal audit, WorldCom said. The firm informed the Securities and Exchange Commission, which already was investigating other aspects of the company's accounting.

"This clearly qualifies for financial fraud," said Alex Mou, a telecom analyst with Hotovec, Pomeranz & Co. in San Francisco. "What it tells you is all the statements the company made in the past basically become a lie."

The accounting maneuvers masked the financial troubles that engulfed the entire telecommunications industry amid a plunge in sales as the economy slowed.

Beginning in the first quarter of 2001, WorldCom began labeling some of its routine expenses as capital expenditures.

By classifying normal expenses as long-term capital expenditures, WorldCom, which had revenue of $35 billion last year, avoided having to deduct the expenses as a cost of doing business. The result was a massive overstatement of net income, the firm said.

The improper transfers totaled $3.06 billion in 2001, with an additional $797 million in the first quarter of 2002. Had WorldCom reported its expenses properly, the company said it would have had a net loss for 2001 and the first quarter of 2002.

WorldCom previously said it earned $1.4 billion in 2001 and $130 million in the first quarter.

"This is really, really shocking, really mind-boggling," said analyst Patrick Comack of Guzman & Co. in Miami. "This could damage overall investor psychology. It would be just like another Enron."

The SEC, in a statement late Tuesday, said the WorldCom disclosures "confirm that accounting improprieties of unprecedented magnitude have been committed in the public markets." The agency said the cases "demonstrate the need for comprehensive market regulatory reforms."

WorldCom and Enron Corp., the discredited energy trader now mired in the largest bankruptcy case in U.S. history, shared the same auditor: Arthur Andersen.

On Monday, Andersen told WorldCom that its audit reports for 2001 and 2002 "could not be relied upon," the company said. WorldCom recently replaced Andersen with KPMG.

"Our work for WorldCom complied with SEC and professional standards at all times," Andersen said in a statement. "It is of great concern that important information about line costs was withheld from Andersen auditors by the chief financial officer of WorldCom."

The disclosure comes at a critical time for WorldCom, which is struggling to rebuild since the departure in April of its longtime chief executive, Bernard J. Ebbers.

After building the Clinton, Miss.-based firm into the nation's No. 2 long-distance company through two decades of mergers, Ebbers was forced out over concerns about declining revenue, mushrooming debt and questionable accounting practices.

It was unclear Tuesday whether Ebbers was aware of the improper accounting. Ebbers and CFO Sullivan were close colleagues at WorldCom, with adjoining offices.

"Our senior management team is shocked by these discoveries," said John W. Sidgmore, who replaced Ebbers as CEO. "We are committed to operating WorldCom in accordance with the highest ethical standards. I want to assure our customers and employees that the company remains viable and committed to a long-term future."

WorldCom has said it did not engage in revenue-enhancing accounting practices that have plagued competitors such as Global Crossing Ltd., which has filed for bankruptcy protection, and troubled Qwest Communications Inc.

The SEC has been looking at other accounting issues and such issues as selective disclosure of financial information, improper commissions and huge loans to Ebbers.

For Sidgmore, the task of turning around WorldCom is now much more difficult, if not impossible. His most pressing concern is the company's $29.3 billion in long-term debt, which analysts estimate is greater than the true value of WorldCom's assets.

Except for MCI, WorldCom has no large, attractive assets it could sell to pay off its debt.

"It'll be hard for WorldCom to avoid bankruptcy now," Comack said. Lenders will be reluctant to give WorldCom money it needs to operate, he and other analysts said.

Enron's bankruptcy filing in December involved total corporate assets of $50 billion. By contrast, WorldCom listed assets of $104 billion as of March 31.

The MCI group provides local and long-distance services to about 20 million residential and small-business customers in the U.S.

Sidgmore insisted that WorldCom's customers would suffer no loss of service. "Our services are in no way affected by this matter, and our dedication to meeting customer needs remains unwavering," he said.

But analysts predicted that the company's customers — especially its lucrative corporate clients — would be vulnerable to poaching by AT&T Corp. and Sprint Corp.

Wall Street has been rocked by financial restatements by major companies in recent months, belying the boom times many firms purported to have enjoyed in the late 1990s.

Other recent restatements have been the result of stepped-up SEC investigations of Fortune 500 companies, including Qwest Communications and Xerox. Corp.

Qwest last week ousted its chief executive amid speculation that an SEC investigation would force the telecommunications company to restate revenue for 2000 and 2001.

In April, Xerox agreed to restate financial results from 1997 to 2001 and pay a record $10-million SEC fine to settle allegations of premature booking of more than $2 billion in equipment-leasing revenue.

Until the WorldCom announcement Tuesday, the largest earnings restatement in U.S. corporate history came from Rite Aid Corp., which overstated net income by $1.6 billion in the late 1990s. Several former Rite Aid executives were indicted last week.